A series of legislative changes have been implemented over the past few years as part of the Government’s focus on ensuring multi-national corporations pay their fair share of tax.
International tax revenue represents approximately 10% of New Zealand’s tax revenue each year. Not only does it need to be preserved, but given international tax practices exhibited by some multi-national companies, it should be expected to grow. However, the changes do not just affect the likes of Google and Apple, but also smaller businesses that undertake cross border transactions.
One area of Inland Revenue’s (IRD) focus is the thin capitalisation (‘thin cap’) regime. Historically, if a NZ company had a loan from an overseas company in the same group, the NZ company could claim a full tax deduction for interest on the loan, providing the ‘debt to assets’ ratio (known as the thin cap ratio) was below 60%.
Although this test remains broadly the same, new legislation has changed the way the ratio is calculated, to reduce the asset value by liabilities that are not subject to interest. This is increasing the thin cap ratio.
Some businesses that have historically been below 60% are now above the threshold, and they are either restructuring their balance sheet to come back below 60% or accepting that their net interest deduction will be restricted.
A related measure is a new set of rules known as ‘Restricted Transfer Pricing’ (RTP). The RTP rule focuses on NZ companies with loans from overseas and seeks to ensure an appropriate rate of interest is charged. Previously a weak NZ balance sheet might have been used to justify a higher interest rate on an unsecured related party debt. However, the RTP rule requires the interest rate to be set with reference to the credit rating of the wider group’s parent company, ignoring non-commercial terms. This is generally giving rise to reductions in interest rates, thereby reducing interest deductions in NZ.
Further rules target ‘Hybrid Mismatch’ arrangements. These arise where a legal arrangement has different tax outcomes in different countries. For example, convertible loan notes are commonly treated as ‘loans’ in NZ, such that a deduction is available in NZ for interest payments. However, they are treated as ‘equity’ (i.e. shares) overseas, such that interest received overseas is not taxed.
A tax deduction in one country with no corresponding taxable income in another clearly erodes the global tax base. IRD’s new base erosion and profit shifting (BEPS) measures basically prohibit a NZ tax deduction if the amount received overseas is not subject to tax in that jurisdiction.
These rules are clearly complex and can be challenging for small and medium businesses to navigate. The IRD is attempting to ensure compliance with the new rules through the issue of a new BEPS disclosure form, which itself is complicated.
For affected entities, the new form applies for income years beginning on or after 1 July 2018. Encompassing these rules within the annual tax compliance requirements not only emphasises the importance of assessing the impact of the new BEPS measures, but also provides IRD with a platform to review and audit these disclosures.